Full Reserve Banking Is No Bailout

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A recent blog by Frances Coppola describes full-reserve banking as ‘the largest bank bailout in history’. In the interests of mutual understanding and accuracy, the following clarification and response addresses a few points that are unclear. We accept culpability for potential confusion here – the submission to the Independent Commission on Banking, which Frances links to, is around 2 years old now, and we’ve advanced our thinking on the proposals since then. A lot of this latest work hasn’t been released yet, but will be in the forthcoming book Modernising Money.

Frances addresses three proposals:
1) The working paper by IMF economists Benes & Kumhof
2) The proposals for Limited Purpose Banking by Laurence Kotlikoff
3) Positive Money’s own proposals in the form that we submitted to the Independent Commission on Banking in late 2010.
The first two have very significant differences to the proposals put forward by Positive Money, so I will leave them aside. I have copied and pasted, in order, the sections of Frances’s post that I want to address:
“Kotlikoff and Positive Money propose cash backing for sight deposits (current/checking accounts) only.”
Strictly, we propose abolishing sight deposits (liabilities of the bank) altogether and replacing current accounts with custodial accounts that allow banks to hold electronic money at the central bank.

In fact all three are, perhaps unsurprisingly, complacent about their proposals and apparently blind to their flaws. Here are a few gems:…

 Positive Money propose that the Bank of England’s Monetary Policy Committee (MPC) should control the money supply so that inflation remains stable. Quite apart from the political implications of this (MPC members are political appointees – why on earth does Positive Money think they would be incorruptible?), there is a serious information problem. The Office of Budget Responsibility’s October evaluation report admitted that they got their growth forecasts wrong by a full 5 percentage points. Under Positive Money’s proposals, the money supply for the economy would be directly determined by such forecasts. Had their system been in force, we would now be suffering serious monetary restriction, not because “banks aren’t lending” but because the MPC had not produced enough money to support growth. In what way is this an improvement over the present system?
Yes, there needs to be efforts to keep the MPC as independent of political control as possible. However, the problems Frances alludes to are far worse in the current system. We are currently suffering a serious ‘monetary restriction’ because banks refuse to lend whilst customers are simultaneously paying down their loans, causing the money supply to shrink. Our version of full-reserve banking ensures that post-reform, the money supply is not increased by bank lending or loan repayments. That means that the money supply would stay constant whether or not banks were lending or not. This is a key point; although it is rarely presented this way, a major purpose of QE (Quantative Easing) was to allow the Bank of England to step in to take over the role of increasing the money supply when the banks stopped lending.

As to the wrong forecasts, it’s extremely difficult to do the forecasts in the current inherently unstable manic-depressive economy with too many distorting factors. One of the major benefits of our proposed reform would be an economic stability. In this environment it will be far more easier to be precise in the forecasts.

“Under full reserve banking, all banks would have to hold enough funds to allow all sight deposits to be drawn at once. To achieve this, central banks would have to produce a simply ginormous amount of new money: the IMF estimates that for the US, it would be 184% of GDP.”

The Positive Money proposals allow the sight deposits of banks to be converted into funds at the central bank (which will belong to the customer). There is no increase in the money supply; simply a conversion of the current risk-bearing accounting liabilities of banks into risk-free electronic money (tokens) at the central bank.

Does this amount to a bank bailout? No, because the sight deposits that were liabilities of the banks will be replaced by a matching-value liability to the Treasury (effectively a face value charge for the money that was created by the banking sector in the form of demand deposits). So there is absolutely no change to bank’s balance sheets. The liability that the bank had to its customers now simply becomes a liability to the Treasury. The bank does not increase its net worth by one single pound. Its assets do not change at all (so it cannot change bad quality assets for good quality ones). This is no bailout.

“Whether a full reserve banking system is “safe” for depositors depends on the trustworthiness of politicians and political appointees. The value of the currency is only as good as the willingness of government to support its value. Which is why inflation targeting is so crucial to economic management…We would be putting a great deal of faith in our politicians not to pursue policies that erode the value of the currency – especially as they, or their appointees, would be directly responsible for producing it.”

This is precisely why we advocate making the MPC independent of the elected politicians that run the Treasury and government departments, but accountable to the Treasury Select Committee. However, Frances also seems to be forgetting the situation that we have today. Never mind placing faith in politicians not to pursue policies that erode the value of the currency; we currently rely on the senior staff at high-street banks not to pursue policies that will erode the value of our currency, even thought those staff are given the incentives to lend more, and create more money in the process. Look at the track record of the people and the institutions that have been creating the vast majority of our currency (and the consequent inflation) for the last 40 years:

 

Will an independent committee, who’s task is to increase the money supply only while inflation is low and stable, manage to produce more inflation than a banking sector that has increased the money supply by an average of 11.5% a year for the last 40 years? It seems unlikely.

“…this brings me to my fundamental moral issue with full reserve banking. Why should the interests of people who have money trump those of people who have not? Why should those who, through no fault of their own, have become dependent on state benefits in order to live, have their standard of living cut to the bone to protect people who have far more?”

I think most people would read the following as being a critique of the current fractional reserve system that allows banks to create the money supply through bank lending. When this system failed, the costs were passed onto taxpayers, and those who were on state benefits are seeing those benefits cut in order to protect the banking system and those very people “who have far more”. Yet Frances seems to believe this is the likely outcome of full-reserve banking, even though it is the proven outcome of the current system.

In contrast to the current system, full-reserve banking allows banks to be allowed to fail with no cost to taxpayers. It allows customers who do not want their money to be put at risk to hold their money in risk-free accounts, and leaves customers who are willing to take risks in order to earn a return, to place that money into risk-bearing investment accounts.
“To maintain a full reserve banking system, we would end up locking ourselves into an economic straitjacket which would seriously disadvantage the poorest in our society (both fiscal austerity and the gold standard are bad news for the poor in economic downturns). How on earth is this progress?”

There is no convincing argument for this provided on the blog, but once again it sounds more like a description of our current system.

“Even the transition to full reserve banking to my mind raises moral issues. If the US can afford to produce $4tn of new money (or debt) to protect depositors, why can’t it afford to produce $4tn of new money (or debt) to relieve poverty and create a decent healthcare system?  If the UK can afford to produce enough new money to back all current accounts pound-for-pound, why can’t it afford to produce enough new money to improve its creaking infrastructure? “

This is an excellent point, but it’s an argument for full reserve banking, not against it. If the UK can afford to create £375 billion through Quantitative Easing in order to pump money into the investment markets, why could it not instead give that money to ordinary people in order to get the economy going and help people escape from a debt trap that is designed into the monetary system? More to the point, why is it a good thing to allow banks to create £1 trillion of new money in just 8 years and put most of this money into property bubbles and speculation, but a bad thing for an independent part of the state to take the power to create money away from banks and use it in the public interest instead?

As to the creaking infrastructure and public services - these are exactly those areas that could benefit from Full Reserve Banking – if the reforms would be implemented as we propose, it would free up resources to improve our infrastructure (and unlike in the current system, without increasing the national debt and consequent costs to the taxpayers.)

The moral issue is not with full reserve banking; it is with the current system.

“We cannot say for sure that there would never be another economic crisis, never another recession that needed fiscal stimulus and extraordinary macroeconomic measures. Banks are not the only cause of economic problems. It would be madness to lock ourselves into an economic system that prevented us from responding appropriately to, say, a major oil price shock. But full reserve banking would force us to do that.”

Again, Frances seems to have forgotten what system we have today. We had a crisis caused by over-indebtedness, and the only policy response that the Bank of England could come up with was a) to lower interest rates to make it cheaper to borrow even more, and b) to create money, via QE, in the financial markets, where it is extremely unlikely to ever reach the real economy or stimulate GDP. The current system has completely failed to respond to a crisis, and there are no policy options that the Bank of England or government can use to get us out of a crisis in the current system.

“As far as I can see, full reserve banking is politically and morally disastrous. Either we would hurt the poor through harmful economic policies, or we would deceive depositors into believing their money is safe when it isn’t. I don’t know which is worse.“

I’m afraid this is based on a deep misunderstanding of the proposals. Again, to anyone who has been alive through the recent crisis, it should be obvious that it is the current system which has harmed the poor, and deceived depositors into believing their money is safe when it isn’t. We’re proposing an alternative to this system. 

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  • Frances_Coppola

    You have not put forward a convincing argument that the problems I identify would not apply in a full reserve system. All you have done is point out that the same problems exist in a fractional reserve system. I would make the same response to you that I already have to Ralph Musgrave. Saying “but the present system does this too” is NOT an argument in favour of full reserve banking. If there is no difference between the two systems then there is no point in changing them.

    Your accounting is wrong. It is not possible to transfer current accounts to the books of the central bank without either creating new money or writing off a large proportion of private debt assets. I did explain this in the post and I note you have ignored what I wrote. I’m quite happy to show you the accounting model that explains this. It is an accounting identity. Your model would effectively create new money: the IMF opted for a debt jubilee.

    The IMF’s model is different from yours; they force banks to obtain funding from the central bank, whereas you allow banks to lend only at-risk depositors’ money. I refer you to my discussion with JKH on my post analysing the IMF’s paper on full reserve banking: perhaps you would like to answer JKH’s questions regarding trend deposit growth under your model?

    Economically, you make exactly the same mistake as the IMF writers. You assume that full reserve banking would create economic stability. What is your justification for that assertion? It is incredibly dangerous. As I pointed out in the post, banks are not the only cause of economic crises.

    • Simon

      “Your accounting is wrong. It is not possible to transfer current accounts to the books of the central bank without either creating new money or writing off a large proportion of private debt assets.”….
      My current account with HBOS which currently has £1500 in it could become an account at the Bank of England, HBOS would administer it for a fee. No extra money would be created, and this money could not be used as a basis for further lending, as it is now. Instead of me being a creditor of HBOS, I now have an account backed by the B of E. The only time I could see a problem occuring is if the account holders did not trust the B of E and all wished to withdraw their money. That scenario would be very similar to the recent run on Northern Rock. However that is very unlikely to occur because the electronic money in the accounts at the B of E would in effect be the same as physical cash, and unlike Northern Rock, the B of E could not take excessive risks with this money, because it is ring fenced. You may get people wishing to withdraw their cash if the Bank of England was seen to be creating too much money, ie too inflationary, under monetary reform proposals, but the reality of the system would be no different to having a current account at one of the private banks.

      • Frances_Coppola

        Simon, the problem lies in your words “wouid become”. The process of moving accounts from private banks’ books to central bank books must involve either creation of new money or debt jubilee. That is because at present deposits balance debt assets on private banks’ books. The accounting for the transfer must involve both creation of a new public liability on the central bank’s books – representing the actual money in people’s accounts – PLUS a new liability in the private banks’ books, representing their liability to the central bank. If you don’t do the second of these, you immediately bankrupt all the banks and write down the value of debt assets balancing transferred deposits to zero – which is effectively a debt jubilee. But the fact that you have to create TWO liability entries means that in effect the money supply has increased by the value of customer deposits transferred to the central bank’s books. I realise this isn’t exactly obvious but it is a consequence of double entry accounting and unavoidable, I’m afraid. I’m happy to walk through the accounting model with you if it would help.

        • Simon

          I don’t agree with this and feel it is just accounting sophistry, or just over complicating matters. I have some limited experience of double entry book keeping having worked for some accountants in my early career but I am sure you are making things more difficult than they need to be.

          • Frances_Coppola

            Simon, my experience of double entry accounting is rather better than yours by the sound of it. I’m really not over-complicating this, but it is important to get it right. You cannot start messing around with double entry accounting rules and standards.

          • Simon

            I am happy to accept your knowledge of double entry accounting is probably better than mine, but I see no real problem if account holders wish to regard their money (or part of it) as a safety deposit box, and invest the rest elsewhere at risk, with no recourse to the tax payer. The same would apply if I drew all my money out as cash, and if everyone did it then the banks would have a severe problem as things stand. The key question still remains, and this where we part company, is who has the right to create money. The Positive Money proposals, if implemented properly, would greatly reduce the risk of bank runs, although I do have some sympathy for your views on your blog where you say that tighter controls over lending is something that should be done. My brother lives in Spain, and he has withdrawn his money from the banks there, because many are insolvent after over lending on property, and seen as very risky. Many others have done the same, and some of their banks only exist because they are on life support money borrowed from the ECB. These problems would not have occurred if the Positive Money proposals were in force, because an individual bank would not have been able to lend beyond it’s investment deposits. I accept the investors and shareholders of an individual bank could have lost all their money, but the bank would have been much more constrained in it’s risk taking in the first place if it could only lend existing money.

          • Simon

            I am happy to accept your knowledge of double entry accounting is probably better than mine, but I see no real problem if account holders wish to regard their money (or part of it) as a safety deposit box, and invest the rest elsewhere at risk, with no recourse to the tax payer. The same would apply if I drew all my money out as cash, and if everyone did it then the banks would have a severe problem as things stand. The key question still remains, and this where we part company, is who has the right to create money. The Positive Money proposals, if implemented properly, would greatly reduce the risk of bank runs, although I do have some sympathy for your views on your blog where you say that tighter controls over lending is something that should be done. My brother lives in Spain, and he has withdrawn his money from the banks there, because many are insolvent after over lending on property, and seen as very risky. Many others have done the same, and some of their banks only exist because they are on life support money borrowed from the ECB. These problems would not have occurred if the Positive Money proposals were in force, because an individual bank would not have been able to lend beyond it’s investment deposits. I accept the investors and shareholders of an individual bank could have lost all their money, but the bank would have been much more constrained in it’s risk taking in the first place if it could only lend existing money.

          • simon

            Frances, you might like to look at my father’s web site too, http://www.legalforgery.com He has spent over 40 years looking at the money supply and banking, and became interested in the subject after the great inflation we had in the 1970s. He has similar views to Positive Money, and proposes using a system of Registered Money as the solution to the problem. Try not to get into a long discourse with him, as he may not have my youthful vigour, although he has extensive knowledge. There is a great illustration on the web site of a horse and carriage rushing to save Backhouses bank in the 1800s, a very early version of Northern Rock.
            I am hopeful that even if Positive Money’s proposals are not adopted, at the very least we will see more competition in the banking sector, with more use of credit unions, things like fundingcircle and even good old “Bank on Dave” in Burnley. I think the government is very keen to stop a bank being “too big to fail”, and to prevent the tax payer having to bail out the banking system. I see these as only sticking plaster solutions however, and they do not address the real issues. God help the European tax payer, if they have to stand behind the ECB while it buys a large chunk of the toxic debt from the Club Med banks. That sort of thing brings the whole banking sector into disrepute. I think auditors and regulators here have a lot of questions to answer too, for effectively letting banks like HBOS and Northern Rock trade whilst insolvent.

          • Frances_Coppola

            You don’t seem very aware of the risks of “only lending existing money”. There is in my view a serious risk of deflation or chronic stagnation with this approach, particularly if the MPC regarded inflation control as more important than growth. Please try to think of the economy as a whole, not just the interests of savers. Safety for savers can result in stagnation for the economy.

          • Simon

            There would be no inflation or deflation if the right amount of money is created. Vince Cable thinks we would have rampant inflation if the government / B of E created money, Tim Congdon thinks the opposite, they can’t both be right. We have certainly had massive inflation under the current system, especially of asset prices. The present system is manic depressive in nature, and it requires constant growth to pay back debt, which is not feasible in a world of declining resources, ageing populations in many countries, expensive fuel supplies, and much manufacturing work now being done overseas. We have to try to replace much of the debt money with debt free money, otherwise the debt burden for all ( I include tax payers here as well) just grows with time.

          • Frances_Coppola

            “There would be no inflation or deflation if the right amount of money is created”.

            Crikey. That is a simply WHOPPING “if”. Did you not read my remarks about the lack of reliable economic forecasting and the impossibility of predicting economic shocks?

            Also, the “right” amount of money is a value judgement depending on what is most important to you – maintaining the value of savings, or maximising employment (there is a trade-off between the two). This is as much a political judgement as an economic one. Maintaining stable inflation at the expense of growth is a subsidy of current savers at the expense of the poor, the jobless and the young. See this excellent post (bit wonkish, I’m afraid) from interfluidity on the iniquity of inflation targeting:

            http://www.interfluidity.com/v2/3359.html

            We don’t just need growth to pay back debt, we need it in order to raise everyone’s standard of living.

          • http://twitter.com/conradvfr750 Conrad Jones

            Do you think that reducing the Reserve Ratio of Banks from 20.5% in 1968 down to a voluntary Reserve Ratio today (averaging around 3%), has made House Prices more affordable?

          • Frances_Coppola

            What makes you think the two are related?

          • http://twitter.com/conradvfr750 Conrad Jones

            If the Reserve Ratio is reduced, the amount of Credit creation is increased, allowing more credit into the Housing Market.

          • Frances_Coppola

            Not true, Conrad. Positive Money are right about this. In a fractional reserve system the reserve ratio makes no difference to lending, because banks create the money they lend. Lending is always a risk vs return decision, and is constrained by capital and regulation, not by reserves.

          • http://twitter.com/conradvfr750 Conrad Jones

            I think the point I was trying to make was, that in proportion to the amount of reserves a Bank now holds, the amount of credit they create has expanded way above the level it use to be twenty or thirty years ago, and has steadily increased with the implicit subsidies and actual subsidies provided by the Government. This expansion of credit has been primarily directed at the Housing Market, which Positive Money have also have researched. If you are trying to make the point that Banks do not have to first take in deposits before making loans, then I couldn’t agree more. I only wish the BBC understood this point as well as you do. Thank you.

          • http://twitter.com/conradvfr750 Conrad Jones

            I think the point I was trying to make was, that in proportion to the amount of reserves a Bank now holds, the amount of credit they create has expanded way above the level it use to be twenty or thirty years ago, and has steadily increased with the implicit subsidies and actual subsidies provided by the Government. This expansion of credit has been primarily directed at the Housing Market, which Positive Money have also have researched. If you are trying to make the point that Banks do not have to first take in deposits before making loans, then I couldn’t agree more. I only wish the BBC understood this point as well as you do. Thank you.

        • Simon

          If you like, £1500 asset on HBOS books (my account, HBOS debit entry), and their £1500 liability to me (HBOS credit entry) both go to zero, and the B of E has a £1500 asset (debit) and a £1500 liability to me (credit), although I think even this over complicates it. Easier for the B of E to effectively have my current account, HBOS just administer the transactions for a fee. This does not increase the money supply.

          • Frances_Coppola

            That would immediately bankrupt HBOS. Your account is neither an asset nor a liability – it is simply an account. The money it contains, as a deposit, is the bank’s lliability to you. It is backed by a share of total debt assets – ie LOANS. If you reduce the contents of your deposit account to zero then unless that deposit is replaced on the bank’s books it is insolvent. That is why funding of deposit drawdowns is so crucial for bank solvency, why bank runs can bankrupt banks, why we have deposit insurance, dammit WHY YOU WANT FULL RESERVE BANKING!!

          • http://twitter.com/conradvfr750 Conrad Jones

            For a custodial account, is Double Entry BookKeeping
            relevant?

            We should look at the Accounting Practices of a Company Such
            as a Gold Dealer who stores Gold for it’s customers’ in Allocated Accounts.

            The Equivalent of what we have in our Bank Current Accounts is
            Unallocated Accounts. A custodial account surely is no longer a liability as the Bank would only safe guard the deposit, not risk it by lending it out.

            How do Gold Dealerships do their Accounting when dealing
            with their Customers Allocated Accounts?

          • Frances_Coppola

            Using custodial accounts is an alternative approach. These would not appear on a bank’s balance sheet and therefore would not be placed at risk by being backed with debt assets. Many banks are already custodians, of course, so changing deposit accounts to custodial accounts wouldn’t be a major change, though it would still leave a funding shortfall for existing loan portfolios which would probably have to be met by borrowing from the central bank – so we are back to our bailout again. But even custodial accounting is still double entry, Conrad. It’s just written from the customer’s point of view rather than the bank’s.

          • http://twitter.com/conradvfr750 Conrad Jones

            From what I understand, the PositiveMoney proposals would not suddenly shift a Fractional Reserve System into a Full Reserve System overnight.
            Existing Loan Portfolios would still remain and would be paid off as usual.
            A transitional period would gradually increase the Reserve Ratio for Banks.
            As you know, we have had a changing Reserve Ratio for the last 50 years.

            1968: 20.5%

            1978: 15.9%
            1988: 5.0%

            1998: 3.1%

            You are totally right to be suspicious of Politicians as it seems that no matter which flavour of Government we have enjoyed, each successive Government has allowed this reduction in Reserve Ratio to continue, bringing an ever more unstable system, fuelling the ability of Financial Institutions to inflate Asset Bubbles, such as Housing.

            Even though you see the Gold Standard as a bad thing, it at least provided some discipline to lending practices which maintained a reasonably stable and affordable housing Market. You are right to say that there are restrictions on having a Gold backed currency – as was proved in the 19th Century in the United States where the Currency Supply shrank causing immense hardship.
            Looking at the Nationwide Housing Price data from 1952 to the Present:
            http://www.nationwide.co.uk/hpi/datadownload/data_download.htm
            seems to show compelling evidence that the lower the Reserve Ratio is, the greater degree of instability there is. House Prices are more unaffordable now and appear to have changed from a means of shelter to a speculative Investment. It’s true to say that the Banks are not only reposnsible for this and there are people who readily boast about how much their “Homes” have increased in “Value”.

            It is difficult to argue that – given our current system has inflated Housing Costs to double what they were a generation ago, is somehow to the benefit of the Poor or even Middle Income Families when it now takes two salaries to buy a House.

            It is evident that in Boom Times, Banks are confident and lend more, thereby increasing the “Money” supply, in times of recession – like now; they are not confident and Governments also put restrictions on Lending, when the money supply is shrinking. The System as a whole is dysfunctional. You are correct, Gordon Brown and Tony Blair went along with it as are George Osborne and David Cameron now. I share your distrust of Politicians but must accept that there are a few excellent Politicians who are interested in understanding the Financial System.

            PositiveMoney’s proposals are to stabilise the money supply and would ensure that Bank Bailouts are no longer lawful. Risky Investments would be just that –Investors who expect large returns will risk losing some or all of their capital, but so too will the Banks.

            Expecting Tax Payers to bail out bad decisions is immoral in my view. This is the current system we have now and not the one that PositiveMoney are proposing. I know you too agree with this as you have pointed out that you do not agree with bailing out Banks. We agree on this.
            I hope that we can all agree that the current System does not work, is immoral and is likely to fail unless changes are made. The only differences in opinion on our collective futures are whether we are to be faced with a massive inflation or (as Steve Keen believes) a massive deflation.

            I understand you have concerns about Full Reserve Banking and look forward to fully understanding those concerns.

          • Bill Davies.

            100% Registered Money v. 100% Reserve Money and Fractional Reserve Banking.

            The trouble with Fractional Reserve Banking in the UK is that it does not exist and never has. We have had a statutory Liquidity Ratio since 1947 This Percentage averaged about 60% at the time Backhouse had to find a lot of gold to pay off the malevolent Duke of Cleveland (Early 1800’s). It dropped to about 30% when the Bank of England accepted the role of lender of last resort in 1886.
            The Liquidity Ratio was fixed at 32% when the Bank of England was nationalised in 1947, and was steadily reduced to 12.5% in 1971 and was finally replaced by a cash deposit regime in 1981, which in 1996 was calibrated to ensure that a bank had enough highly liquid assets to meet its outflows for the first week of a liquidity crisis without recourse to the inter-bank market, to allow the authorities time to explore options for an orderly resolution. See Chapter 6 of http://www.legalforgery.com for more details.
            Banking I propose a variant on 100% Reserve which I call 100% Registered Banking. The title Registered instead of Reserve is intended to describe a simple transformation of all bank deposits to be registered at the Bank of England where they would remain the property of the banks. This process is described in more detail in Chapter 10 of Legal Forgery

          • DozyHole

            Very interesting, I have been reading the book on your site.

            You currenty link to bendyson.com, I think you should consider adding positive money too.

          • http://twitter.com/conradvfr750 Conrad Jones

            You are right to enthasise the Moral Hazzard of “bailouts”.
            We would not be back to “our bailout again” as the lending decisions and risk associated with investment accounts would be born by Banks and their Investors.

            The lack of a Bailout would help restrict the amount of loans available for speculative non-productive assets – like housing.

          • RJ

            Thank you Frances for mentioning DE book keeping

            I believe there are significant problems with full reserve banking. PM really need to show the full double entry journal entries FOR ALL RELATED PARTIES including the UK GOVT to back any proposal they make.

            Double entry book keeping can not be avoided. It’s like night and day. Its a fact of life that reflects monetary reality as money is created and destroyed as a financial asset (and equal liability) by journal entry. And the accounting rules are being strengthened to ensure flawed financial reporting (arising from suspect transaction recording) does not occur.

          • DozyHole

            There has always been government created money(cash,coins etc), at one time I think it was as much as 50% of the money supply.

            How did the book-keeping look back then?

            So how can book-keeping be a problem all of a sudden? We gradually increase cash and coins(or equivalent) as bank credit decreases, how far you want to go is a good question.

          • RJ

            How did the book-keeping look back then?

            Exactly. This is critically important but where is this explained on PMs website.

            Govt spending backed by notes and coins (a financial asset and liability) rather than Govt bonds (another financial asset and liability) will not magically make the Govt debt disappear. Yet many think it will.

          • John Morrison

            RJ, Notes and coins are not a liability of the government. The government does not redeem them, we do when we accept them in payment for something.

            National notes andn coins do not fit the asset and liability model bacause they are not a debt contract, they are straightforward money, effectively evidence of contribution to the nation.

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        • Bob Welham

          You say “if you don’t do the second of these, you immediately bankrupt all the banks.”

          I take this to mean that if you do not add to the commercial banks’ balance sheets new liabilities to the central bank (to replace their former liabilities to depositors) then this inaction will bankrupt the banks.

          But if you do not replace the banks’ old liabilities to depositors with equal new liabilities to the central bank, then are you not simply eliminating their deposit liabilities? Since under reform the commercial banks retain their debt assets (e.g. mortgages), then surely this elimination enriches rather than bankrupts them?

          Am I misunderstanding you?

          • Frances_Coppola

            Bob, yes you’re right – it would considerably increase shareholders’ equity. My bad, too many late-night posts! So my argument should really be – why would we want to create a new central bank liability on bank balance sheets, thus exposing the central bank to credit risk, when we could use that equity windfall to write off much of the private debt that is weighing down our economy and crippling economic growth?

    • Sampson

      This comes down to a difference in your definition of “money”.

      Clearly you don’t consider the money in my bank account to be money, as 97% of it was issued by the private banks. Yet I can (and do) spend it like money. Sorry Frances but your analysis is flawed, due to this misunderstanding. The “money” in my account is accepted as money, so the conversion from private bank money, into central bank money does not increase the net money supply by a single penny. As for writing off the private debts, we that is not necessary, but what would be the problem? The deposits are guaranteed so nobody would loss out on money they already have, just the future profits from the interest payments. The up side would be the release of government, individual and non-bank businesses to spend and invest. Debt, after all, is the millstone currently dragging the west to its final resting place in the deep. And before you start spouting “moral hazard” nonsense, just think of the moral hazard of allowing the board of directors of a profit making company to create its own money. Chilling, both in terms of economics, but also in terms of the loss of democratic accountability. Further to the writing down of debt. I note that my friends in Iceland are doing really rather well from allowing the banks to fail (and converting deposits into central bank money, thus protecting savers) and writing down the debts,. Can you explain why they are not suddenly the Wiemar Republic?

      The stability created by full reserve banking should be obvious to even the most economically illiterate person; it prevents a run on a bank having any contagion and, lets face it, why would there ever be a run on a bank if we all know that our money is safe? It makes no sense whatsoever.

      I cannot get past the notion that your analysis is little more than Neo-Liberal propaganda for the Banksters. You seem to deliberately twist the issues surrounding the current system and point them at the alternatives. You appear to be little more than a mouth piece for the status quo.

      • Frances_Coppola

        No, Sampson, you are mistaken – as you would know if you had bothered to read any of what I have actually written about this. I do not see the money in your bank account as “not money”. Indeed I have made the point many, many times that a deposit created through lending and a deposit made by a customer are indistinguishable.

        You also seem to think I don’t want debts written off and I want bank bailouts to continue. You are utterly and completely wrong. Indeed my reasoning in raising the question of debt jubilee here is that Positive Money completely ignore the millstone of private debt and seem to think that private debts backed by public money (yes, I know they don’t define it as that, but that’s what it is) on private bank balance sheets is a good thing. I beg to differ – I think the debts should be written off.

        Because you are starting from a complete misconception of what I actually think, I see no point in discussing with you. Go and read what I’ve written, if you want a debate.

        • DozyHole

          “Positive Money completely ignore the millstone of private debt and seem to think that private debts backed by public money (yes, I know they don’t define it as that, but that’s what it is) on private bank balance sheets is a good thing. I beg to differ – I think the debts should be written off.”

          Positive money are far from ignoring this, in fact it gets to the core of the problem as they perceive it, and their solution addresses this very point. It is positive moneys long term aim to reduce private debt, but they realise this is not possible overnight, hence the initial situation you describe.

          “I think the debts should be written off”

          I know you realise that this means less money in the economy, you probably have an idea of how to write it off without destructive consequences? Perhaps print money and give it to the people, a debt jubilee, this would lead to more public money and less debt based bank credit? If this is your idea(or similar) then it’s not that different from positive moneys solution, just does not go as far.

          • Frances_Coppola

            I think it is quite possible to reduce private debt “overnight” – and indeed I think this is the best solution for debtors, for savers and for the economy as a whole. I’m broadly in agreement with Steve Keen on this: private debt jubilee funded by central bank money is the best way of dealing with the present situation. In that it uses central bank resources, this is similar to Positive Money. But that’s where the similarity ends. Neither Keen nor I want to change the monetary system. We want to fix the economy. Big ideas are all very well, but to fix an economy you have to deal with the big problems. And the biggest brake on economic recovery by far is private debt. That’s what I want to deal with.

          • RJ

            The central bank can not (and should not be allowed to if they could) do this.

            Private debt write off is in effect and payment to a select group. Those that willingly took on debt will benefit at the expense of those that do not. It is hard to justify this but if the Govt did decide to do this it should rightly be recorded as a Govt (treasury) expense.

            Secondly central bank resources. What is this What are these resources?

            You seem to misunderstand what a financial asset is. A financial asset has value because it is backed by a financial liability held by another party. The central bank does not have the power or resources to write off large private debt. But the UK Govt does. Because the Govt has the POWER TO TAX. It spends and recoveries this spending money by taxing. Or issuing bonds.

            So the Govt and only the Govt can reduce private debt (by increasing Govt debt).

          • Frances_Coppola

            RJ,

            I don’t think you appreciate the extent of a central bank’s powers.

            The Bank of England has already taken on some private debt under the Asset Purchase Facility for corporate bonds:

            http://www.bankofengland.co.uk/markets/Pages/apf/corporatebond/eligibility.aspx

            This could be widened to allow the Bank of England to buy loan portfolios directly from banks. The purchases would of course be done through a separate SPV, as indeed the current asset purchase programme is. The procedure as outlined in the IMF’s paper on full reserve banking (although their accounting is not right) would be for the central bank to issue money directly to households and companies specifically for paying off debt. This would write off significant amounts of private debt leaving deposits untouched. The central bank’s balance sheet would expand to accommodate the extra money issued and a backing asset equal to the private debt repaid with that money.

            If the effect of issuing new money for private debt repayment were to increase inflation unacceptably, then the central bank could raise interest rates and/or government could increase taxes to reduce the money in circulation. As the backing asset on the CB balance sheet is not “real” – unlike the securities purchased under QE – it would automatically reduce as the money in circulation declined.

            In the UK, the central bank’s accounts are consolidated into the Whole Government Accounts. When this is done, both the money in circulation and the backing asset would “appear” to be on the government balance sheet.

          • RJ

            “this could be widened to allow the Bank of England to buy loan portfolios directly from banks.””

            This will not reduce private debt. It will simple transfer a debt asset held by a commercial bank to the central bank. The debt liability holder will simple owe the central bank rather than the commercial bank

            “would be for the central bank to issue money directly to households and companies specifically for paying off debt.”

            This is just wrong. The central bank can not issue money directly in this way without something in return. (Like the house the debt liability holder purchased with this debt)

            The central bank must balance their books. If they just give reserves (not money) away and receive nothing in return. A loss will result.

            The Govt and only the Govt can spend and create bonds out of thin air to pay for this. Even commercial banks need to balance assets and liabilities.

            So the TREASURY (not the central bank) can make a loss financed by bonds. The central bank can not just decide to hand money out to their mates (and a few very lucky selected plebs) to reduce their debt. And rightly so.

        • John Morrison

          Hi Frances,

          Unlike others, I do not think you are a neo-liberal apologist. I think you are correctly sounding alarm bells according to how things look from where you are. To a large extent the difference between your views and mine is down to what we have seen and where we put our faith.

          I take your point that banking and finance is too complex for the government to proscribe and control the whole of it. I also believe that Positive Money are picking too open a fight with banking which will fight back and justifiably claim that it is under attack.

          I suggest that the government concentrates on carrying out its proper monetary role which is to issue a common currency whose issue mobilises public work and whose subsequent circulation facilitates private trading. It should carry out this role in full and leave the banks to work around it as they wish.

          The steps to carry this out are:

          Establish a national bank providing accounts with payment facilities and backed in full by the B of E. This should be bank that anyone can choose to use and also should be the natural refuge for the sight deposits of failed banks.

          All government spending that is chiefly directed at mobilising national labour or resources should be paid for by taxation and currency issue only. Borrowing for these purposes should stop. Quite simply, if the nation does not have the money to pay enough tax then the government should issue more money until it does.

          I think this is enough.

          It does break the central bank firewall. Government will issue currency straight into the economy as payment for public work but that firewall has no business being there. Now that banks have inflated the money supply with their credit to the extent that it represents 97% of our use we seem to be scared of making any increases to the remaining 3% that is real money.

          Increasing real money in this way will not be inflationary. All of the new money has to be earned into existence so all of it represents an addition to the common wealth and those that earn it will not have to borrow it. Every pound of new money will be a pound earned that does not need to be a pound borrowed. Loans will be repaid and new loans will be smaller. Banks in turn will be more careful about extending credit because they will be operating in new market conditions created by the establishment of a national bank.

          The government should not aim to stop private credit which can often act much faster and more strategically than government action but it should strive to maintain the common currency as the money that most people use.

          We do not need government to interfere with banking. We need the conventions of banking to stop interfering with the proper monetary role of government. We should not need the permission of private banks to issue our own currency, rather they should need our permission to handle it.

          • Frances_Coppola

            John, I don’t in principle have a problem with any of this.

            I don’t want anyone to get the idea that I’m not in favour of governments issuing national currency. Like you, I consider national currency issuance and control to be a key function of a sovereign government. At present government delegates the issuance of most money to private banks: it is not correct to suggest that the money issued by private banks is not “real money” or is issued without government permission. Positive Money is in effect suggesting that the permission that private banks currently have to issue currency should be revoked, and all currency should be directly issued by the central bank. I disagree with them: I would like to see government exercising tighter control over the means by which banks create money, namely lending, but I think centralised money issuance would be too restrictive. Like you, I think there is a role for “credit” money in our economy.

            As I’ve said, I don’t think government should “intrinsically” have a preference between debt issuance or money issuance: really it’s the same as the choice between debt or equity financing for a large corporation, but without the corporation’s tax advantage from debt financing (which I would like to see ended). Much of the reason why governments don’t like using money financing is its historic association with hyperinflation, but as I have explained elsewhere, I think this association is false: a responsible government managing an economy that is not in a state of collapse should be able to finance its spending through money issuance without significant impact on inflation. The requirement on government to issue debt is a relic from the gold standard.

            Breaching the central bank firewall is an issue, though, because that would have to be a deliberate policy decision and after that it would be very hard to claim that monetary policy was in any way independent of fiscal policy or indeed of politics. For this reason it might be more sensible to back your “national bank” with government guarantees rather than central bank guarantees. I realise this is a fudge and no-one should be fooled, but there are a lot of very silly people out there in the financial world, and unfortunately many of them have far too much influence.

            Inevitably, a national bank providing government guaranteed current accounts would be popular, which would over time have an impact on the funding of private banks as private current accounts migrated to the new banks. I’d guess that private banks would have to securitise more of their loans and perhaps rely more on the central bank for funding.

          • Frances_Coppola

            sorry, that should be “migrated to the new BANK”, not “banks”.

          • John Morrison

            Frances, thanks for your comments. I only have a few things to add.

            I think there is a difference between debt issuance and money issuance. Although they may have the same net effect, the way in which they do it is significantly different. Debt issuance requires repayments and that money has to be found by increasing taxation or cutting spending, often painfully and usually unfairly. Money issuance does not provoke that particular crisis, there is just the problem that overcooking it will provoke inflation. If all adjust to it equally (and the UK knows well how to do this) the main effect of inflation is a reduction in the value of savings and debt. Everyone seems to be scared of savings loosing value (which they don’t have) while they are up to their necks in disproportionate debt which a bit of inflation would relieve nicely. As I have said before, a relentless repayment schedule is more painful than money loosing value. Ïn the case of property we need a bit of inflation to bring debt on property in line with its value.

            I know that breaching the central bank firewall is the big taboo, it is the chain that binds us, a barrier between the nation and its money. There is sense in trying to go in under the radar to tackle this. Providing accounts of the existing National Savings Bank with the full range of payment facilties that all other banks have would take us quite a long way towards preparing the ground without actually making the breach. It would just be overdue modernisation of an antiquated service – what argument is there against that?

            When you say “I’d guess that private banks would have to securitise more of their loans and perhaps rely more on the central bank for funding. ”, it seems that you are overlooking the possibility that banks might have to downsize their loan portfolios a bit. The nation will not need them to make so many loans. This should not put them out of business but paying out billions in bonuses may become impractical for them.

          • Frances_Coppola

            John,

            Completely agree with you about the inflation scare crippling us. Randy Waldman (Interfluidity) argued recently that inflation targeting is effectively a subsidy to savers. Personally I think we should be targeting NGDP, not inflation. And I agree with you that savings are as much a bubble as debt and need to be allowed to deflate. Though they are already doing so, of course, through negative real interest rates.

            Governments should in my view see both money and debt issuance as economic policy tools. It could be that in an economy where inflation is the main risk, governments may prefer to issue debt because expectation of higher taxes to pay the interest would act to calm down inflation: conversely, in a stagnant or deflationary economy, money issuance would be more appropriate, since people should respond positively to expectations of (slightly) higher inflation. This would of course make coordination of monetary and fiscal policy essential. Various economists (Krugman, Wren-Lewis) have been arguing along these lines recently: not surprisingly they want economists to control both monetary AND fiscal policy, which has implications for democracy since fiscal policy involves taxation. However, once monetary and fiscal policy are coordinated, the central bank’s firewall becomes irrelevant.

            I think one of the most important features of the IMF’s recent paper on full reserve banking was its (undeclared) assumption that the central bank and government were indistinguishable. This is a major departure from their usual insistence on central bank independence, and suggests they may be feeling their way towards a different paradigm. The whole paper is worth a read – it’s very flawed but it speaks volumes about the direction of IMF research at the moment.

            When I talked about securitisation, I was thinking about managing existing loan portfolios as deposits declined, rather than taking on new ones. Over time, banks could of course reduce their loan portfolios – in fact they are already doing this. We don’t like the effect much, though, do we!

          • John Morrison

            We don’t like the effect when government feels unable to print money but of course that is the issue we are addressing.

          • John Morrison

            We don’t like the effect when government feels unable to print money but of course that is the issue we are addressing.

        • RJ

          There are two sides to debt

          The debt liability and
          The debt asset

          A debt write off means less money or less savings (or both). We currently need more money and more savings so more debt not less is needed. The only option at present is more Govt debt to over time replace private debt.

          • Frances_Coppola

            Yes, RJ, I agree. I have written about this before – the “other side” of debt is savings. I disagree though that we need “more” savings. We need less debt, not more savings.

            The BoE’s Haldane in his recent speech to Occupy commented on the asset bubble that grew in the run-up to the 2007-8 financial crisis. That was blown up by leverage, and it has not been allowed to collapse because everyone is terrified of losing savings. When will people realise that savings are as much a bubble as the credit which created them?

            The “gentle” way of allowing debt to fall is for Government to take it on then tax or inflate it away over time: the “gentle” way of allowing savings to fall is to erode them through low interest rates and/or inflation. Both are happening at the moment, but the pace is very gentle indeed and I think it could be faster, at least as far as debt reduction is concerned.

          • DozyHole

            “The “gentle” way of allowing debt to fall is for Government to take it on then tax or inflate it away over time: the “gentle” way of allowing savings to fall is to erode them through low interest rates and/or inflation. Both are happening at the moment, but the pace is very gentle indeed and I think it could be faster, at least as far as debt reduction is concerned.”

            I agree with this analysis.

            It’s interesting that there is an argument for bank created credit that says it responds quicker to demand and can be created immediately at source. The same argument should allow a retraction in credit, but this is never desired or allowed, I would argue that we accept the argument for bank credit for better and for worse, only then would we see the true extent of the devastating effects of private money creation.

            This ‘gentle’ way is just a convenient way of covering up for, and propping up the current system.

          • John Morrison

            I agree that the ‘gentle’ way is sticking plaster but lets do it, we have a gaping wound to deal with. It will return some power to the people. The burden of un-payable debt is crippling and complicates monetary solutions.

          • John Morrison

            Changing the monetary system is unlikely to occur overnight with a bang. The process is more likely to be like a game of chess. You cannot go straight for checkmate. First you have to make a number of moves to prepare the ground and either make some effort to distract your opponent from realising the true significance of your moves or else make them so that it is impossible to fight back.

          • DozyHole

            I disagree, this ‘gentle’ recovery helps to hide the true cost of almost unlimited credit creation over the last decade and more. It’s not a good thing, once all the savers have seen their saving devalued and conditions for lending are favourable again the whole process will repeat.

            And on your point of allowing the government to create money without restricting bank created credit, are you sure you have thought this through? I would think you need to restrict one type of money or the other, you may be able to strike a good balance with regulation or other means but banks would have to be forced to take a lesser role in money creation.

          • John Morrison

            Hi DozyHole

            Government printing money and not restricting private credit is something I have thought through. I am not expert enough to work through all the detailed causes and effects but I can see how excessive credit extension is not going to be encouraged by the widespread use of government issued money.

            The essential difference is that government issued money is earned into existence and bank credit money is borrowed into existence. Quite simply, as more money is earned, there will be less need to borrow it. Demand for credit will fall. People are not completely stupid, they only borrow when they can’t earn. Earned money you spend and you are done whereas with borrowed money you have to work out how to pay it back with interest.

            The changed monetary landscape will also curb the appetite of banks to lend. They may face a haemorrhage of deposits as some people move their cash to the safer national bank but more importantly the greater use of cash safely deposited in the national bank with the full range of payment facilities is going to change how the credit of banks is perceived. We still persist in considering cash to be more concrete than credit but we put that aside when the quantity of cash becomes difficult to physically handle and settle instead for the convenience of a credit transfer. If cash held in the national bank has the same convenience as bank credit then some traders may take insistence on payment in cash to a much higher level. This will of course depend on how frail bank credit is perceived to be. Banks will no longer enjoy the automatic confidence that they do today. They will have to earn it and making foolish loans will work against this.

            The most important thing is that government will print money, get things done with it and leave it circulating instead of borrowing money to get things done and then having to pay it back with interest. Taxes should be for the recirculation of government money when enough has been printed, not for making repayments to private investors.

            I want to see nothing less than proper social money as the mainstay of our economy and what most of us use. Meanwhile our life support system (I mean that literally) is the current monetary system and we are still some way from changing it and we have to consider two things:

            If it breaks, then a lot of people will get hurt, mostly the poorest people.

            There is a concerted neo-liberal effort to use the current system to reduce the power of people to zero and we have to resist that or we will not have the power to change anything.

            What I am saying is that the current system has a huge influence on our power and we may have to learn how to play it in our favour before we can change it.

          • DozyHole

            I agree with almost everything you say.

            I’m just a little unconvinced that the government could suddenly start spending new money while banks are leveraging it up also. I feel positive moneys solution is the best description of how we would move from what we have now to what you describe as desirable.

            The great thing about PM proposals is that we go from 3% money to 100% very gradually over time. At some point we will meet the optimum ratio of money to credit, although there may be no way of knowing we are at that point. My instinct tell me that if it’s not 100% money, it will be pretty close.

          • John Morrison

            I agree that the ‘gentle’ way is sticking plaster but lets do it, we have a gaping wound to deal with. It will return some power to the people. The burden of un-payable debt is crippling and complicates monetary solutions.

          • RJ

            Less savings means that people will not have enough money when they retire

            We need more savings so that people do not need to rely on low Govt pensions after retiring. Lower tax and compulsory savings would solve many of our current problems

            It’s an irrational fear of Govt debt that is the cause of many of our current financial problems.

    • Sampson

      This comes down to a difference in your definition of “money”.

      Clearly you don’t consider the money in my bank account to be money, as 97% of it was issued by the private banks. Yet I can (and do) spend it like money. Sorry Frances but your analysis is flawed, due to this misunderstanding. The “money” in my account is accepted as money, so the conversion from private bank money, into central bank money does not increase the net money supply by a single penny. As for writing off the private debts, we that is not necessary, but what would be the problem? The deposits are guaranteed so nobody would loss out on money they already have, just the future profits from the interest payments. The up side would be the release of government, individual and non-bank businesses to spend and invest. Debt, after all, is the millstone currently dragging the west to its final resting place in the deep. And before you start spouting “moral hazard” nonsense, just think of the moral hazard of allowing the board of directors of a profit making company to create its own money. Chilling, both in terms of economics, but also in terms of the loss of democratic accountability. Further to the writing down of debt. I note that my friends in Iceland are doing really rather well from allowing the banks to fail (and converting deposits into central bank money, thus protecting savers) and writing down the debts,. Can you explain why they are not suddenly the Wiemar Republic?

      The stability created by full reserve banking should be obvious to even the most economically illiterate person; it prevents a run on a bank having any contagion and, lets face it, why would there ever be a run on a bank if we all know that our money is safe? It makes no sense whatsoever.

      I cannot get past the notion that your analysis is little more than Neo-Liberal propaganda for the Banksters. You seem to deliberately twist the issues surrounding the current system and point them at the alternatives. You appear to be little more than a mouth piece for the status quo.

  • chefdave5

    Why are we trying to place artificial restrictions on credit creation? This is doomed to fail. Only the market can make the correct decision, if your wage is £x then it doesn’t take much for a bank to work out how much credit you can realistically manage, even if it is created out of thin air. (Wouldn’t it be great if we could create all commodities out of thin air!)

    I think you’re in danger of over-engineering a solution to a problem that doesn’t exist. The economy would respond much more positively to a land value tax for example in exchange for a reduction in the taxes that generally diminish our productive capacity.

    • DoozyHole

      “Only the market can make the correct decision”

      This is a good point. I would point out that the value of money is flexible, if the market was so great then we could have a constant amount of money, as long as it is sufficiently divisible and allow the market to decide its value. I am not proposing we should have a constant money supply of course, but it should not be as elastic as it has been recently, a compromise might be a good idea?

      “problem that doesn’t exist.”

      You do not see a problem so from your point of view you are correct. For those of us who see the problems then it is a different matter. Having the whole money supply as a debt on the nations public and businesses’s is such an obviously bad idea I can’t believe it’s what we have. A compromise here perhaps?

    • Samspon

      “Only the market can make the correct decision”

      If the last 5 years have taught us anything, it is that the “market” is subject to manipulation and distortion. That the “market” serves only those with capital. Look at the bloody mess (low wages, crippling debts, crumbling infrastructure and 30 years of declining investment) and tell me the market works?

    • Samspon

      “Only the market can make the correct decision”

      If the last 5 years have taught us anything, it is that the “market” is subject to manipulation and distortion. That the “market” serves only those with capital. Look at the bloody mess (low wages, crippling debts, crumbling infrastructure and 30 years of declining investment) and tell me the market works?

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  • Petr Toman

    It would be interesting to get more detailed opinion of prof. Keen – he also mentions PositiveMoney and states: ‘I don’t see the banking system’s capacity to create money as the causa causans of crises, so much as the uses to which that money is put. As Schumpeter explains so well, the endogenous creation of money by the banking sector gives entrepreneurs spending power that exceeds that coming out of “the circular flow” alone. When the money created is put to Schumpeterian uses, it is an integral part of the inherent dynamic of capitalism. The problem comes when that money is created instead for Ponzi Finance reasons, and inflates asset prices rather than enabling the creation of new assets.’ (http://www.debtdeflation.com/blogs/manifesto/)

    • Frances_Coppola

      Thank you Petr. This is consistent with my reading of Keen and the brief conversations I’ve had both with him and with people at Cullen Roche’s site (Modern Monetary Realism) about endogenous money creation. However, some full reserve supporters have claimed Keen’s support in comments on my blog.

  • Sampson

    You are mistaken if you think these sorts of analysis are based upon misunderstanding. They are not. Clearly this is a propaganda piece on behalf of the Neo-Liberal Banksters.

    I think your response is spot on except for one point. The value of the zombie banks shares would increase, as they would become much safer investments once there huge liabilities were taken away. This is clearly another positive, as it should increase the returns to our pension pots and to the tax payers (as we essentially own the bloody bailed out banks).

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